"As the global economy emerges from its worst slump since the 1930s, we envisage plenty of inflation fertilisers at stake, especially in the United States. Inflationary trends could emerge due to a combination of factors, including the cyclical recovery as countries try to get the pandemic under control and gradually lift mitigation measures. This will come at the same time as a super-sized US fiscal stimulus, supply chain bottlenecks, pent-up demand and savings, and upward pressure on wages. In addition, the infrastructure plan is likely to be passed by the US Congress in late-2021, unfolding its impact mainly in 2022-23 and in the longer run. These trends will join forces with more structural trends and a likely regime shift towards higher inflation as a way out of the crisis, as highlighted in the paper “Don’t give up on fundamental valuations”. On the Fed’s side, the central bank has been insisting that inflationary pressures are transitory, but at the end structural is just something temporary which has lasted for sometime. And investors should be ready for this!
Higher inflation will have huge investment implications and any portfolio construction exercise should be approached with this regime shift in mind. In bonds, upward direction of rates (non-linear) and inflation warrant a more cautious and active stance on duration, while searching for income across the entire market spectrum with a global unconstrained approach. In equities, where we are risk neutral for now, given the high valuations in some segments and some pause in momentum, higher inflation may dent valuations, especially those at expensive levels. Instead, investors should favour the multi-year rotation from growth to value stocks both in the United States and Europe. Equities exposed to resources and infrastructure as well as high dividend stocks could be interesting in an higher inflationary regime. On the contrary, caution is needed towards rate-sensitive – high duration stocks. At a cross-asset level, higher inflation will challenge traditional portfolio diversification, as the equity-bond correlation turns positive. Solutions that target real returns with a broad range of asset classes will be attractive in this respect."